Buydown Mortgages

A buydown mortgage is a type of mortgage where the buyer attempts to obtain a lower interest on the mortgage. Some buydown mortgages are temporary lasting for periods of one to five years, while some buydown mortgages are for the entire duration of the mortgage.

The mortgage lender offers the borrower the lower interest rate because the seller of the house puts an amount of money into an account to subsidize the loan to the borrower. The money that the seller puts into this account is raised by adding it to the purchase price of the home.

The advantage to the house buyer is that the payments are reduced, at least for a few years, and this allows the purchaser to qualify for a larger mortgage. If the buydown is temporary the mortgage interest will increase once the buydown period is over.

The most common buydown mortgages are the 3-2-1 and 2-1 mortgages:

• The 3-2-1 buydown mortgage has the mortgage interest reduced 3% for the first year, 2% for the second year and 1% for the third year. After the third year the interest rate goes to the full amount for the balance of the 30 year term.
• The 2-1 buydown mortgage has the mortgage interest reduced 2% for the first year then 1% for the second year. After the second year the interest rate goes to the full amount for the balance of the 30 year term.

In order for the lender to give the interest reduction the seller has to put into an account the cost to the mortgage lender. For example, assume a 3-2-1 buydown mortgage on a $350,000 home when market interest rates are 6.75%. The lender loses about $16,800 over the three years (roughly $7,800 in year one, $6,300 in year two and $2,700 in year three). The seller therefore has to deposit $16,800 into an account in order for the lender to offer the buydown mortgage.

Advantages:

• Lower payments mean that a homebuyer can qualify for a larger mortgage.
• There is no negative amortization period. Every payment results in the full interest being paid as well as the principal being reduced.
• The interest rate is fixed for the entire mortgage and discounted for a known time period thus there are no unknowns for the homepurchaser.
• The payments increase over a period of time (usually two or three years) rather jumping all at once.
• Rather than reducing the price of the house the seller can offer a buydown mortgage. Often the cost to the seller of a buydown mortgage is less than if they were to reduce the price of the house.

Disadvantages:

• Most buydown mortgages are temporary lasting a set time of less than five years (two and three years being the most common time periods). After this time the payments will increase.
• The buydown fee is added to the price of the house being purchased so you end up paying more for a given house.